Making an Offer an Owner Can’t Refuse

In New York City, real estate transactional volume has been on an impressive and consistent upward trajectory. In 2014, the number of deals closed in the five boroughs totaled 2,104; this is up 11 percent over 2013, 25 percent over 2012, and a staggering 125 percent over 2011. Based on these figures, you would imagine buyers are absolutely swimming in opportunities. And yet, most investors will tell you that the scarcity of product, or stated differently, their diminished exposure to available product, stymies their ability to transact. What gives? How is it that volume is so high while everyone complains that there is no product?

Beyond the obvious fact the demand far outstrips supply, there are several market conditions forcing this disconnect between volume and perceived scarcity of product. First, the business case for selling an asset is often extremely murky. Despite the fact that pricing is unprecedentedly high, sellers are often reluctant to trade because they don’t want the capital gains exposure, and because selling high means buying high if they plan to reinvest via a 1031 exchange. Second, in case of larger General Partners with sponsor positions, a sale can trigger imbalance in their own corporate infrastructure. Most importantly, debt has never been this cheap, and taking tax-free proceeds from a refinancing is a compelling way to monetize an asset. Given this environment, few would-be sellers independently elect to initiate a formal marketing process; instead, they are approached with a number higher than they imagined was attainable. The unsolicited, often direct offer can have the power to persuade an owner to change his or her business plan.

Clearly, the tail wags the dog when the untested offer drives the business decision to sell. But it helps explain why volume remains high, yet most investors are struggling with an acute shortage of available product. I spend the majority of any given day talking and meeting with investors. The refrain, “I would have paid more…” is all too common. Maybe it is simply frustration talking, or maybe it is just another argument for accommodating some level of market efficiency within a decision-making process around whether or not to transact. Given the number of flips we are reading about, there is real merit to the latter.

Still, the reluctant sellers are right to remain hesitant despite tremendous pricing. Simply put, not every deal should be an outright sale. Last year, I worked on a complicated transaction in which the sellers came very close to taking a $50 million offer. The pricing was phenomenal—higher than the nearest comps by roughly 35 percent. Ultimately, the sellers got a better deal by structuring a ground lease with a leasehold mortgage. The total capitalization of the structured deal was actually less than the $50 million purchase offer by about 10 percent. But a more tax-efficient structure netted the would-be sellers higher-net cash distributions while retaining an ownership position.

My Ackman-Ziff colleagues and I regularly take on assignments in which a sale is not the foregone conclusion. While the strength of the sales market cannot be underestimated, a multi-track approach (i.e. simultaneously pursuing a sale or a joint venture recapitalization) can yield the right transaction at the right time. Regardless of deal structure, the disconnect between volume and availability is a major opportunity for potential sellers; they can take advantage of this supply-demand conceit by conducting an intelligent, flexible process. Instead of being reactive to the ad hoc offers, hesitant sellers should pursue optionality with the right team—one that can not only produce the highest offer but also test the sale hypothesis against what the capital markets can do.